Bank of England's next move on interest rates

What's the risk -- inflation or slowdown?

Fed officials reluctant to signal more easing

Demand for safety as European politics raises uncertainty has resulted in lower US Treasury yields and a stronger buck. Despite softer U.S. data, Fed officials have indicated their reluctance to engage in further QE. This past week, Dallas Fed President Fisher reiterated that he would not support new quantitative easing and Minneapolis Fed President Kocherlakota maintained his hawkish stance saying that the bank may need to cut stimulus in 6-9 months. Lacker reinforced his reasons for dissenting on the language to keep rates low through 2014 and Pianalto expressed her optimistic outlook for economic growth this year. Taken together, recent comments from Fed officials indicate that the bar is relatively higher for another round of QE as conditions would have to deteriorate significantly before such action would be warranted.

With dampened hopes for additional easing, yields have responded more to risk aversion. In an environment where QE3 speculation is high we tend to see lower Treasury yields, higher equities, and a weaker dollar. What has been observed recently is an environment that appears to be driven more by risk sentiment with lower Treasury yields, lower equities, and a stronger dollar. As such we anticipate sentiment to continue to be a main factor driving the USD in the week ahead with a bias for a stronger dollar. On the data front, U.S. CPI numbers are scheduled for release on Tuesday and are expected to show above-target inflation which supports the view that the Fed will not engage in further stimulus.

Technical analysis is constructive for the dollar as the dollar index is trading above the 80.00 level and daily ichimoku cloud. The index also broke above a medium term bear channel, which began in mid-Dec, suggesting continued upside. The channel can be seen by connecting the highs of January, March, and April and bringing a parallel line to down to connect the lows of Dec. 21, early Feb., and late Feb. The top of the channel is currently around the 100-day simple moving average which is at about 79.60 and the convergence of the daily cloud top, base, Tenkan, and Kijun line is around the 79.40/60 level which is likely to be a significant pivotal area. While the zone holds as support we would expect further upside potential in the dollar.

Broader risk environment outweighs Japanese rhetoric

The Japanese yen has been a strong performer this week despite recent measures by the Bank of Japan to ease further as well as increased rhetoric from government officials stating Japan’s readiness to act on the currency if needed. Action by the BoJ to increase asset purchases and in longer dated maturities did little to stem JPY gains. USD/JPY broke below the 80.00 figure and price action has been contained within the weekly ichimoku cloud that sees the top and base at about 80.44 and 78.11 respectively. The yield differential between UST’s and JGB’s has moved in favor of a lower USD/JPY and increased risk aversion with renewed political uncertainty in Europe have resulted in yen gains. Broader market sentiment has been a main driver of the JPY and may continue to outweigh domestic policy.

Japanese finance minister Jun Azumi said earlier this week that Japan is closely watching for speculative yen moves and that the yen rise may be partly caused by EU politics. He also stated that Japan is ready to act immediately on the yen if needed. The rhetoric did not deter JPY longs as yen strength resumes. We have seen this in the past with comments from the BoJ reiterating their commitment to powerful easing. The market is indicating that it does not see officials as a credible threat and even recent interventions and central bank activity in the past has failed to have a lasting impact.

We expect the yen to be range bound as it consolidates within its weekly cloud and amid relatively light data flow in the week ahead. Of note, Q1 GDP figures are scheduled for release on Thursday and are expected to show that the economy grew +0.9% q/q from the prior -0.2% contraction. Rhetoric from officials has been uninspiring as they have reiterated prior comments without strong action to back them. Therefore unless there is a distinct shift in tone we expect the market to continue to shrug off the usual comments.

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